City Watch: Charles Sylvester on why a mild correction could be good for equities
After a four-year equity bull market, many global equity markets are near record highs and some valuations look stretched.
In the short-term, a healthy development for equities could actually be a period of consolidation, or a mild correction.
The most recent upward moves in equities appear to have been driven by speculation and liquidity, rather than by fundamentals such as earnings per share or dividends. The problems in the US with the debt ceiling and budget saga have temporarily delayed tapering and, in general, the continuation of loose monetary policies has helped to fuel financial markets.
Meanwhile, third-quarter corporate results have been disappointing. In Europe, the Q3 reporting season has seen the worst revenue performance since 2009.
The problems in the eurozone crisis have been contained by the European Central Bank (ECB) President promising to do “whatever it takes”, but some new issues are emerging on the continent. According to the US Treasury, Germany is damaging global growth due to its large current account surplus; clearly, Germany needs to stimulate domestic demand in order to help rebalance the global economy.
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In addition, for the second month in a row, three of the four big countries in the eurozone have inflation rates at 1% or below and Germany is not much higher, at 1.3%. This is worrying because there has been a broad fall in inflation and, with excess economic capacity in the region, there are disinflation risks. Rather belatedly, the ECB decided to reduce interest rates to a record low of 0.25%. Hopefully, it will make the euro currency more competitive and cap market interest rates.
Although global equities are not as good value as earlier in the year, investment flows could make them more expensive. This would not be unsurprising as in an economic recovery, equity prices tend to overshoot. We are positive on the outlook for equities in 2014 but are mindful that some of the old problems may confront us again.
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: : Charles Sylvester is an investment manager with Charles Stanley & Co in Ipswich.